. Henry, a direct descendant of Jefferson Morgan has inherited $450,000. A finan

Question

.    Henry, a direct descendant of Jefferson Morgan has inherited $450,000. A financial advisor tells her to invest this amount and target an average of at least 8% return over a 30 years. Henry decides to invest in a Northern Endowment Fund that has had a ten year average return of 8.5%. During the same time, S&P500 has had a 13% return (this is market return). The risk free return is 2% and the beta of the fund is 0.8. (15 PTS)

a.    What is the discount rate? (10 PTS)

b.    Would a beta of 1.1 increase her returns? (5PTS)

Explanation / Answer

We can calcualte discount rate using CAPM:

Beta = 0.8

Return on Market = 13%

Risk Free Rate = 2%

Discount Rate = 2% + 0.8 * (13% - 2%)

Discount Rate = 10.80%

Part B:

Beta = 1.1

Discount Rate = 2% + 1.1 * (13% - 2%)

Discount Rate = 14.10%

As discount rate has increased, it implies the increase in return of the portfolio

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